Financial Centres: Past, Present & Future

London and Hong Kong, two of the world’s leading financial centres, have uncertain futures. Ed Kilcommons discusses their rise to the top and how their ‘stickiness’ has kept them there. He then looks at several striking trends which together suggest that this time may in fact be different and that the future of global financial centres should be questioned.

London and Hong Kong are at risk

Four years ago, the Brexit result gave rise to fears that London’s historic financial sector might take flight to a European competitor, such as Frankfurt or Paris. To some degree, this is already underway, with EY research finding that by June 2019, £1 trillion of assets and 7,000 banking jobs had already moved from the UK to the EU, with this figure likely to be a “drop in the ocean” of the final cost.¹ Especially damaging would be the loss of ‘passporting rights’ for firms in the event of a no-deal Brexit (an ever possible and worryingly likely outcome, with negotiations currently stalling over politically-charged fishing rights).

‘Hong Kong’ translates into English as ‘fragrant harbour’ or ‘spice harbour’, indicating its initial role under British colonial rule. Its financial sector evolved more gradually, developing significantly from the 1970s onwards and becoming a global force around 20 years ago. Hong Kong has consistently ranked 3rd in the biannual Global Financial Centres Index (GFCI), since its first edition in March 2007. However, in GFCI 27 (March 2020) Hong Kong fell from 3rd to 6th (surpassed by Tokyo, Shanghai, and Singapore). This was largely triggered by prospects of a U.S.-China decoupling and increasingly assertive moves by China to curb Hong Kong’s autonomy. These seismic geopolitical shifts threaten to undermine Hong Kong’s position as a laissez-faire, yet politically stable gateway to China, thus raising fears that its financial sector may take flight to another Asian centre.

How London and Hong Kong became global players

London’s rise:

• London rose with Amsterdam as the world’s dominant financial hubs following the decline of Antwerp from the 1550s, triggered by widespread government defaults on gargantuan war debts and compounded by the Dutch Revolt (1568-1648).²
• London eventually usurped Amsterdam in the late 1700s, as major external shocks in the form of the American and French Revolutions severed the symbiotic relationship between the two centres, facilitating the City’s rise to unchallenged dominance.³
• Perhaps since the end of WWI (1918), London has shared its mantle with New York. In 2017, London boasted the largest net export of financial services in the world at £68bn.⁴

Hong Kong’s creation:

• Hong Kong’s initial post-war boom was fuelled by a wave of migrants fleeing the violence of the Chinese Civil War, which ended in 1949.⁵
• Its development as a leading financial centre in the last two decades has been largely fuelled by its unique role as the ‘gateway to China’, connecting the Western and Eastern financial spheres.

The ‘stickiness’ of financial centres

Historically, financial centres are extremely ‘sticky’. They only shift suddenly when confronted by a sufficiently unstoppable geopolitical force. This stickiness exists because there are significant benefits of scale for financial centres. A diversity and depth of services and skills creates a powerful centripetal force.

Usually developing around commercial and industrial hubs, financial centres often linger for at least a few decades after the wider economic winds have departed. We see this in the medieval Italian city-states of Venice and Milan, as well as early-modern Antwerp. Arguably, modern London also demonstrates this trend, remaining a dominant global financial centre despite Britain’s significant economic decline since World War I. It is a testament to the City’s gravity and continued evolution that London has maintained its position for c.100 years since Britain became a second-rate economic power.

Both London and Hong Kong have withstood numerous challenges in the past, demonstrating the ‘stickiness’ of financial centres:

London

• 1974 ‘May Day’ in New York eliminated minimum commission charges, making trading far more competitive.
• 1990s Launch of the European Single Currency and the European Central Bank. It was widely predicted that Frankfurt would usurp London as the locus of European finance.

Hong Kong

• 1984 The Sino-British Joint Declaration, agreeing to the handover in 1997, triggered significant emigration to Canada, Australia, UK, US, Singapore. Similar to today, predictions of Hong Kong’s demise arose.
• 2003, 2012, 2014, 2016 all saw significant post-handover protests. Of course, these have re-emerged since February 2019, a crisis which has spilled over into that of the new national security law.

After facing numerous seemingly existential threats in the past, as well as weathering global crises in the form of wars and economic crashes, might one conclude that the risk posed by contemporary events is overstated?

Does suggesting that London and Hong Kong are currently at risk peddle the exceptionalist fallacy that ‘this time is different’?

Is this time different?

Financial centres generally rise and fall due to major geopolitical shocks. However, both London and Hong Kong have seen off frequent threats to their position in past years and decades, demonstrating the ‘stickiness’ of financial centres. So how should we consider their futures in the face of Brexit and the new national security law?

‘Drawing out lessons’ from history is a farce. Consciously or not, one merely draws on the past to support an agenda in the present. Each situation is too different from the next. The world is simply too complex to be boiled down into clear ‘lessons’ or iron ‘rules’ of history.

But to blindly declare that ‘this time is different’ might be equally foolish. This Time Is Different: Eight Centuries of Financial Folly (2009), a book written by two Harvard economics professors, highlights how people consistently believe that their position is exceptional.⁶

However, Kenneth Rogoff, one of two authors, has recently suggested that this time might actually be different. The coronavirus pandemic is unlike anything since the 1918 Spanish flu, “but the world wasn’t rich enough back then to be able to shut down the way it has now. Back then, the growth effects were pretty temporary and mild compared to what I think we are seeing and going to see here.”⁷ This certainly appears to be borne out in the data…

Global annual change in real gross domestic product (GDP), 1900-2020:

Two more changes: GFCI and Globalisation

Since the great financial crash, there’s been a striking and unprecedented convergence of leading financial centres. Whilst the top centres, New York and London, have maintained their ratings in the Global Financial Centres Index, the rest of the top 10 have significantly caught up. Perhaps a dramatic shift of the financial centre, as we’ve seen in Europe (from Antwerp to Amsterdam to London), is unlikely in the modern day. Is an increasingly shared and collaborative relationship more likely? There are interesting parallels here to Amsterdam and London’s temporarily symbiotic relationship from the mid-seventeenth century to mid-eighteenth century.

Since the end of WWII, we’ve seen an ever-closer connectivity of global financial markets. Is this trend reversing? In a recent article, I discussed the U.S-China decoupling (see LinkedIn for more). This, along with Brexit and the coronavirus pandemic, threatens to seriously set back globalisation.

London and Hong Kong are key epicentres in these events:

• Brexit is the first time that a member state has left the European Union. The world’s 5th largest economy severs ties with the world’s largest trading bloc.
• A significant decoupling would undermine Hong Kong’s unique proposition as the East-West gateway. With Chinese companies delisting from the U.S., and American tech firms and global banks reconsidering their future in Hong Kong, the ‘fragrant harbour’ could be in trouble.

Possible futures for global financial centres more widely?

Might we see ‘global’ financial centres become less viable, as straddling an East-West gulf becomes increasingly difficult? Will regional centres once again become the norm, as was the case in early-modern Europe with Bruges or Antwerp in the North complemented by Venice, Florence, or Lyon in the South?

Will location cease to matter? Could extended remote working and advanced digital capabilities signal the end of traditional financial centres and the rise of a ‘digital financial centre’ unbridled by geography, a crowded commute, and an eyewatering cost of living?

• London has benefitted from an ideal location between U.S. and Asian time zones and a close proximity to Europe.
• Hong Kong has been defined by its position connecting the Western and Eastern financial spheres, offering an invaluable ‘gateway to China’. If location became less important in the future, any traditional financial ‘centre’ would be threatened.
• This seems very unlikely, at least in the foreseeable future. Working remotely will become more common and perhaps even the norm in the post-pandemic world, but the relevance of location for recruitment, innovation, competition, and services seems unlikely to recede any time soon. Furthermore, other central factors such as legal, regulatory and tax systems, time zones, and personal relationships, each dependent on geography in their own way, will surely remain crucial factors in the fate of financial centres.
• However, extended remote working and a prolonged economic downturn could certainly make shifting operations away from a threatened London or Hong Kong easier than before. The opportunity cost of transferring operations to Frankfurt or Singapore is going to be less painful than normal when half of your workforce is on furlough and work has been reduced to a trickle. A precedent has already been set for this, with several countries and companies accelerating the re-shoring of key operations from China during the pandemic, driven by security and decoupling concerns.

Key takeaways

• Financial centres are extremely ‘sticky’ but can shift suddenly following seismic geopolitical shocks. Both London and Hong Kong were created by these forces, they might yet decline by them too.
• London will not lose its dominant position in global and European finance anytime soon. However, it seems likely we’ll see meaningful shifts to European centres, and a generally more interdependent relationship develop. To a significant degree this is already happening (see the GFCI convergence since 2007 and post-2016 UK to Europe flows). Passporting rights and a no-deal Brexit remain potentially catastrophic unknowns.
• Hong Kong more seriously threatened. However, its vulnerability can be overstated. It’s not in either China’s or America’s interests to fully decouple financially or otherwise, and China would do serious damage to itself by smothering its golden goose. However, critical shifts are in motion as we speak, and so Hong Kong’s fate is even less predictable than London’s.
• Global financial centres are changing.
  • Though a fully remote financial sphere is not yet feasible, digital and remote working are becoming more important while distance becomes less relevant. COVID-19 has dramatically accelerated this trend.
  • Leading global financial centres have converged significantly since 2007, which, in conjunction with a possible East-West decoupling might make global firms and centres less dominant.

Evolution Partners

Evolution Partners pioneered a ‘remote-first’ model way before the pandemic forced the rest of the world to. However, even for a digitally enabled and agile firm, there are clear advantages to location (as evidenced by our growing operations in Hong Kong, London, Paris and Australia) which allow us to operate seamlessly in an increasingly digital and remote world, whilst maintaining a presence across a range of leading global financial centres.

Sources

¹ The Independent, 26 June 2019, https://www.independent.co.uk/news/business/news/brexit-cityof-london-jobs-financial-services-banking-impact-a8975711.html

² Peter Spufford, ‘From Antwerp and Amsterdam to London: The Decline of Financial Centres in Europe’, De Economist 154 (2006), pp. 143-175. https://doi.org/10.1007/s10645-006-9000-7

³ Ann M. Carlos and Larry Neal, ‘Amsterdam and London as financial centers in the eighteenth century’, Financial History Review 18.1 (2011), pp. 21-46. http://eprints.lse.ac.uk/3879/1/Amsterdam%20and%20London%20as%20financial%20centres%20in %20the%2018th%20century%28lsero%29.pdf

⁴ TheCityUK, 25 October 2018, https://www.thecityuk.com/news/uk-leads-the-world-in-financial-andrelated-professional-services-exports/

⁵ David Fickling, ‘Can Hong Kong Keep Its Status as Asia's Financial Center?’, Bloomberg, 2 December 2019. https://www.bloomberg.com/graphics/2019-opinion-will-tokyo-taipei-singaporebe-next-hong-kong/index.html

⁶ Carmen M. Reinhart and Kenneth Rogoff, This Time Is Different: Eight Centuries of Financial Folly (Princeton, 2011).

⁷ Caleb Silver, ‘Rogoff: Why This Time is Really Different’, Investopedia, 15 June 2020. https://www.investopedia.com/rogoff-why-this-time-is-really-different-5024875

Images and graphs (in order):

US-China flag -Wikimedia, https://commons.wikimedia.org/wiki/File:FlagUSA_FlagPRC_crash.svg

UK flag -Wikimedia https://upload.wikimedia.org/wikipedia/commons/thumb/a/ae/Flag_of_the_United_Kingdom.svg/12 00px-Flag_of_the_United_Kingdom.svg.png

EU flag -https://iconarchive.com/show/flags-icons-by-wikipedia/EU-European-Union-Flag-icon.html

Global GDP growth graph - IEA, Global annual change in real gross domestic product (GDP), 1900.2020, IEA, Paris https://www.iea.org/data-and-statistics/charts/global-annual-change-in-real-gross.domestic-product-gdp-1900-2020

GFCI ratings graph - All GFCI data and references from ‘GFCI 25 – Explore the Data / GFCI Over Time’ (https://www.longfinance.net/programmes/financial-centre-futures/global-financial-centres.index/gfci-25-explore-data/gfci-over-time/) and GFCI 27 (https://www.longfinance.net/media/documents/GFCI_27_Full_Report_2020.03.26_v1.1_.pdf)